No surprise, US inflation accelerated in April – but the data released yesterday showed that it accelerated more than expected for both headline and core figures: the former rose to 3.8% – heavily impacted by the rapid rise in energy prices – while the latter, core inflation, the version that excludes food and energy prices due to their volatile nature, rose to 2.8%. Both are significantly higher and decidedly moving away from the Fed’s 2% inflation target. That was the predictable outcome of the Iranian war, which pushed US gasoline prices around 65% higher since the beginning of March.
On the front line, the Middle East war is at a standstill. The latest news suggests that Iranian crude exports from the main export port, Kharg Island, have just stopped. The US and Iran are incapable of finding an agreement to reopen the Strait of Hormuz. Oil flows are disrupted and global oil reserves are nosediving, pushing oil prices higher. Crude oil rose by more than 3% again yesterday and is consolidating above the $100pb mark this morning. Cherry on top, Russian oil flows also slowed last week, as several drone warnings reportedly disrupted ship loadings there.
Higher oil prices push inflation higher, but not only that. They also tame economic activity by raising operating costs for businesses. For households, they squeeze affordability.
In the US, for example, headline inflation now equals wage growth. Leading names including McDonald’s and Kraft Heinz warned last week that consumers are running out of money, meaning that if Americans keep spending, they will have to do so by taking on more debt. Consumer loans are already at record highs and still mounting, while interest rate cuts are no longer on the menu du jour. Not an excellent setup for healthy growth.
Elsewhere, the picture is no sunnier.
In Germany, the divergence between inflation and growth expectations is striking: it is screaming stagflation – high inflation, low growth. Energy crisis v2, resurging inflation, the trade war, Chinese EV competition, too much regulation, too much bureaucracy… Germany hasn’t been able to get its head above water since the Ukrainian war. The rest of Europe is also slowing and struggling as higher energy prices eat into purchasing power. To make matters worse, the European Central Bank (ECB) is expected to hike rates – maybe twice, maybe more – in the second half of the year to fight inflation.
Across the Channel, Brits are grappling with their own political shakeups after Nigel Farage scored big in the latest elections. The name Farage resonates in markets as a clearer path toward looser fiscal policy, higher spending and larger deficits, just as investors are already worried about Britain’s debt and inflation outlook. That combination is pushing investors to demand higher compensation to hold UK government debt, sending the UK 10-year gilt yield back above 5%. That’s the highest level since 1998. The higher the borrowing costs, the less the government can borrow, and the impact on growth would be negative. That’s why higher yields are weighing on sterling appetite; Cable tested the 1.35 level to the downside yesterday, while bears were also encouraged by a stronger dollar following the US CPI data.
And even in quiet and peaceful Switzerland, price pressures are being loudly felt at the pump, meaning that even a strong franc is not enough to fight back against energy-led inflation.
As such, global bond traders are worried – worried that central banks will have to raise rates to tame inflation.
Economists are worried too – worried that rate hikes will not do much other than further slowing economies without necessarily deflating prices, as the problem does not come from the demand side but from an external factor that will not go away with higher rates.
For the US, cutting rates into rising inflation is no longer an option, even with the Federal Reserve’s (Fed) brand new central banker who would – we all know – lower rates as soon as he could. But first, the war in the Middle East would need to end.
Meanwhile, AI spending continues to keep the US economy afloat – at least better than Europe’s. The jobs market is slowing, but payroll numbers continue to defy the mass layoffs announced by Big Tech and the threat of slowing consumer spending.
As such, the US 2-year yield – the best proxy for Fed rate expectations – rose to 4% yesterday after the hotter-than-expected inflation data.
The US dollar also rose, on the back of higher oil prices and a hawkish shift in Fed expectations following the inflation report. USDJPY advanced above the 100-DMA and headed toward 158.
On the equities front, the S&P 500 – which has been fully ignoring rising yields for a month – finally blinked and fell, before recovering losses as dip buyers stepped in near 7340. Amazingly, futures have also flipped back into positive territory from earlier losses.
The market is so crowded with dip buyers that the dips barely become perceptible.
But every new point on the S&P 500 and Nasdaq feels like another Jenga block balancing on borrowed stability.
I say that because the Korean Kospi erased $300bn in less than 100 minutes yesterday after a high-ranking politician floated the idea that the biggest winners of the AI race – we’re looking at you Samsung and SK Hynix – should pay citizens a “dividend” through taxes on AI profits. Earlier this month, Samsung’s labour union also demanded that 15% of operating profit be handed to chip division employees. Fifteen percent. Otherwise, employees would go on an 18-day strike. Apparently, the company and the union have not yet reached an agreement, increasing the likelihood of a strike, while the memory chip shortage driven by massive AI demand remains one of the biggest stories in the tech industry.
Nevertheless, Samsung is rebounding this morning thanks to strong buying appetite on expectations that the company could earn $220bn in operating profit this year. Yes, that’s more than Apple and Alphabet. Only Nvidia – the world’s most valuable company – is expected to earn more.
The latter has been fuelling investor appetite for months, leading to a 455% rise in Samsung’s stock price over the past year, more than a 1000% rally in SK Hynix shares and a 250% rise in the Kospi over the same period. All are deep in overbought territory, all calling for a healthy correction to release the building pressure before moving higher again.
